The revised Direct Tax Code will give a big edge to retirement products over equity and equity-linked mutual funds, which are slated to be burdened by long-term capital gains tax after a long time
Strong winds of change are set to blow over the financial landscape in India. The government has proposed a new tax bonanza for long-term savings schemes under the new Direct Tax Code (DTC) while bringing long-term gains from equities and equity-linked mutual funds under the tax hammer. This dual move could potentially give a leg-up to savings schemes like the New Pension Scheme (NPS) and Public Provident Fund (PPF) over equities and equity-linked products.
Under the existing system, savings schemes fall under the EET (exempt-exempt-taxed) regime, wherein contributions and accumulations are exempt from tax but withdrawals are taxable at applicable marginal rate of tax. However, the government received numerous representations for doing away with the EET system, as this method of taxation of permitted savings was considered harsh in the absence of a universal social security system as in the US. Earlier, the Pension Fund Regulatory and Development Authority (PFRDA), which administers the NPS, had called upon the finance ministry to bring about a change in the tax structure. It appears now that the government has heeded the call and proposed to bring long-term savings schemes like the NPS under the EEE (exempt-exempt-exempt) regime.
Interestingly, at the same time, the government has sought to levy tax on capital gains arising from sale of investment assets such as equity shares of a listed company or units of an equity-oriented fund, which are held for more than one year. This tax is proposed to be computed after allowing a deduction at a specified percentage of capital gains without any indexation. Currently, gains arising out of transfer of equity instruments are taxed (at 15%) only if sold within a year of investment. Capital gains arising out of investment held for more than a year are not taxed.
These new provisions under DTC are expected to have far-reaching implications on the investment scenario in India. Until now, equities and equity-linked mutual funds were considered good bets from the tax point of view, as there was no incidence of long-term capital gains tax. India was among the very few nations that allowed capital appreciation over a period of one year or more to be tax-free. This may no longer be the case. Could this move bring about an exodus from equity instruments to long-term savings schemes?
Sandeep Vasa, a certified financial planner (CFP) believes people could potentially move away from equity markets. "Even today, people are not very comfortable with equity markets. This move could have an impact on the stock markets as people could move further away from equity and equity-linked mutual funds. They will now probably look more at Section 80C investments. Already, people have invested in products like PPF where they know they are comfortable under the EEE system."
Vivek Rege, CFP, VR Wealth Advisors Pvt Ltd said that there could be a natural preference to retirement products as they would come under the EEE system. "People would now be incentivised to invest in such products for tax savings.
They will definitely be seen in a better light. It is good that the NPS would also be eligible for tax exemption; it should see a pick-up in subscriptions from here on." Speaking about the impact on equity investments, Mr Rege said, "Taxation of long-term capital gains will surely affect equity investors."
Devesh Shah, another CFP, welcomed the move to bring the NPS under the EEE system. "This is a move which was required since a long time. It will give right direction to create a social security system in the country. It will be a very favourable feature for personal savings for retirement."
As suggested yesterday, the market is taking a breather before the next move which is possibly up
The market accrued marginal gains in trades today. The Sensex ended the day at 17,462, up 50 points (0.3%) and the Nifty closed at 5,233, up 11 points (0.2%). The indices started the day with a sharp rise, taking cues from the global markets. However, they traded in a narrow range, touching an intraday low in the early afternoon session. Recovery from that point was limited, as gains were pared in late trading.
Asian markets were up on a report indicating growth in New York manufacturing, which brought back hopes that a recovery was underway in the US. Key indices in Indonesia, Japan, South Korea, and Singapore were up by 0.71% to 1.81%. Markets in China, Hong Kong and Taiwan were closed for the Dragon Boat Festival holiday.
US markets rallied on Tuesday as the euro gained against the dollar after a number of successful European debt auctions eased investor concerns about the eurozone's solvency crisis. The Dow was up 213.9 points (2.1%) at 10,404.77. The S&P 500 rose 25.6 points (2.3%) at 1,115.23 and the Nasdaq gained 61.9 points (2.7%) at 2,305.8.
Back home, the Reserve Bank of India (RBI) said that rates are not indicative of the high growth in the economy and should be curbed by controlling interest rates. Planning Commission deputy chairman Montek Singh Ahluwalia said that weekly movements in India's inflation will not have any impact on reforms to free fuel prices.
The monsoon is running four to five days behind schedule and has yet to reach half of the country. After an initial halt, the monsoon has reached the rice, cane and oilseed growing south-western region of India. However, it is yet to reach the soybean-growing areas of central India.
The government (after market hours) on Tuesday, 15th June, proposed the imposition of capital gains tax on all stock market transactions by Indians and overseas funds as a part of the proposed changes in tax laws. As per the second draft of the Direct Tax Code (DTC), the securities transaction tax (STT) will stay and rates will be calibrated. In the first draft of the DTC unveiled last year, the government had proposed to scrap the STT. The DTC has proposed taxing gains from investments in the stock market and also equity-linked mutual fund units at the applicable rate of taxation. The DTC has also proposed some taxes on income of foreign funds, treating all incomes from their investments in the stock market in India as capital gains.
Foreign institutional investors were net buyers of Rs590 crore on Tuesday. Domestic institutional investors were net sellers of stocks worth Rs351 crore.
PBA Infrastructure (up 0.2%) has received a contract from Maharashtra Industrial Development Corporation (MIDC) for construction of a road and allied work at IT Park-II (Phase-I) in the Nagpur Industrial Area. The contract is worth Rs14.33 crore.
International Specialty Products, a US-based chemical supplier, has forged a manufacturing alliance with Vivimed Labs (up 1.1%) for production of UV absorbers. The alliance will allow the two companies to jointly market specific products used in sprays and lotions.
Dynamatic Technologies (up 1.3%) said that deliveries of the first sets of Air Frame Structures for India's largest defence programme, the Sukhoi 30 MKl fighter bomber, have commenced from the company's facility in Nasik. The Air Frame Structures include canards, ventral fins, horizontal stabilisers, slats, vertical fins and air brakes. The assembly transfer from its Bengaluru facility to the new facility, provided by Hindustan Aeronautics at Nasik, will be completed by August 2010, enabling Dynamatic to offer greater production support to HAL.
Essar Oil (closed flat) on 15th June, issued $115 million Foreign Currency Convertible Bonds (FCCBs) due June 2028 to promoter company Essar Energy Holdings Ltd, for part-financing expansion programmes of the company. The FCCBs are convertible into Global Depository Shares (GDS) or equity shares, at the option of the bondholders, at a conversion price of Rs138 per share.
The revised draft has proposed significant changes in 11 areas; the most important includes doing away with all tax exemptions and EEE treatment to long-term investment products and taxing of capital gains on shares
Almost after one year since the government came out with the first draft of the Direct Tax Code (DTC), it has proposed several significant changes in the revised draft with respect to minimum alternative tax (MAT), capital gains taxes-among others-heralding a lower tax regime.
However, unlike the first draft, the revised draft does not specify any tax rate.
The most important changes include doing away with all tax exemptions, characterisation of foreign institutional investors' (FII) income as capital gains, abolition of securities transaction taxes (STT), exempt-exempt-exempt (EEE) treatment to all kind of long-term saving investment products such as provident funds, annuity and life insurance products. The DTC also suggests taxing long-term capital gains on shares and equity mutual funds and classifies short-term capital gains on such products as normal income to be taxed fully. If these three provisions are implemented, equity prices will come down by 20%-30%.
The revised draft also puts pension administered by the interim regulator Pension Fund Regulatory and Development Authority (PFRDA), including pension of government employees who were recruited since January 2004, under EEE treatment. The first DTC draft had proposed to tax all savings schemes including provident funds at the time of withdrawal, bringing them under the exempt-exempt-tax (EET) mode.
Under EEE mode, contributions in certain savings schemes become tax-exempt as they are deductible from income, the accumulations are also exempt from tax till they remain invested and withdrawals are also not taxed. However, in EET, the first two steps remain tax-exempt, but withdrawals are taxed.
MAT will continue to be calculated with reference to the book profits as against previously proposed gross assets, elimination of distinction between short-term and long-term assets on the basis of the length of holding and dilution of general anti-avoidance rules (GAAR).
FIIs would also be no longer subject to withholding taxes like TDS, rather, their income would be taxed as capital gains irrespective of the fact whether they have a permanent establishment in India or not, unless they are covered by any double-tax avoidance treaty.
There also is a proposal to restrict interest deduction u/s 24 on income from housing properties to just one self pre-occupied house.
The revised draft has proposed changes in around 11 areas. However, there is no mention of any tax slabs. The first draft had proposed three slabs for income-tax, a tax rate of 10% on income up to Rs10 lakh, 20% for income up to Rs25 lakh and 30% thereafter.
According to the revised draft, the proposals in this revised discussion paper would lead to a reduction in the tax base proposed in the DTC. The indicative tax slabs and tax rates and monetary limits for exemptions and deductions proposed in the DTC will, therefore, be calibrated accordingly while finalising the legislation.
The revised discussion paper on DTC, which would help replace the decades old Income-Tax Act, has retained the tax exemption for up to Rs1.5 lakh paid as interest on housing loans. However, both the first and revised drafts are silent on the exemption given on principal amount paid on housing loans. At present, borrowers can enjoy exemption on payment of principal amount. However, it is part of exemption to savings capped at Rs1 lakh per annum. Interestingly, the first draft had proposed to revise this limit to Rs3 lakh a year. Under the revised DTC, taxation of non-profit organisations would be rationalised to include basic exemption and allow carry-forward of surplus up to specified limits.
The revised draft proposes to levy wealth-tax on all taxpayers, except non-profit organisations (NPOs). However, in case the NPO ceases, taxation at 30% of its net worth-proposed in the first draft of the DTC-will continue. At present, wealth-tax is levied only on unproductive assets. The second draft proposes to calibrate threshold limit for levy of wealth-tax and rate of wealth-tax in the context of overall tax rates.